Derivatives and Hedging Activities

Risk Management Objective of Using Derivatives

We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future contractual and forecasted cash amounts, principally related to our borrowings, the value of which are determined by changing interest rates, related cash flows and other factors.

Cash Flow Hedges of Interest Rate Risk

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish these objectives, we use interest rate swaps and interest rate caps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three and six months ended June 30, 2017 and 2016, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt and forecasted issuances of fixed-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.

During the three months ended June 30, 2017 and 2016, we recorded ineffectiveness of $11,000 (increase to interest expense) and $120,000 (increase to interest expense), respectively, and during the six months ended June 30, 2017 and 2016, we recorded ineffectiveness of $14,000 (increase to interest expense) and $163,000 (increase to interest expense), respectively, mainly attributable to a mismatch in the underlying indices of the derivatives and the hedged interest payments made on our variable-rate debt and due to the designation of acquired interest rate swaps with a non-zero fair value at inception.

Amounts reported in "Accumulated other comprehensive income" related to derivatives designated as qualifying cash flow hedges will be reclassified to interest expense as interest payments are made on our variable-rate or fixed-rate debt. During the next twelve months, we estimate that an additional $130,000 will be reclassified to earnings as an increase to Interest expense, which primarily represents the difference between our fixed interest rate swap payments and the projected variable interest rate swap receipts.

As of June 30, 2017, we had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:

The fair value of our interest rate derivatives designated as hedging instruments at June 30, 2017 included $1.9 million of asset derivatives reported in Other assets and $3.6 million of liability derivatives reported in the Fair market value of interest rate swaps in the Condensed Consolidated Balance Sheet. The fair value of our interest rate derivatives designated as hedging instruments at December 31, 2016 included $2.4 million of asset derivatives reported in "Other assets" and $7.6 million of liability derivatives reported in "Fair market value of interest rate swaps" in the Condensed Consolidated Balance Sheet.

Bifurcated Embedded Derivatives

Additionally, as a result of the Merger (see Note 2), on December 1, 2016, we issued 867,846 shares of MAA Series I preferred stock as consideration. These shares are redeemable, at our option, on and after October 1, 2026, at the redemption price per share of $50 (see Note 10).

This redemption feature embedded in the MAA Series I preferred stock was evaluated in accordance with ASC 815, Derivatives and Hedging, and we determined that we were required to bifurcate the value associated with this feature from its host instrument, the perpetual preferred shares, and account for it as a freestanding derivative on the balance sheet at fair value as a result of the call option.

Thus, the redemption feature embedded in the MAA Series I preferred stock is reported as a derivative asset in "Other assets" on the accompanying Condensed Consolidated Balance Sheets and is adjusted to its fair value at each reporting date, with a corresponding adjustment to Other non-property income or expense. The embedded derivative for these preferred shares was initially recorded at a fair value of $10.8 million at the date of the Merger and as of December 31, 2016 and then subsequently adjusted to fair value of $14.1 million at June 30, 2017. This $3.3 million year-to-date increase includes a purchase price allocation adjustment of $1.6 million related to the Merger opening balance sheet date, which was recorded in the six months ended June 30, 2017, as well as $1.7 million year-to-date mark to market adjustments to record the change in fair value of the derivative asset in the six months ended June 30, 2017.

Tabular Disclosure of the Effect of Derivative Instruments on the Condensed Consolidated Statements of Operations

The table below presents the effect of our derivative financial instruments on the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2017 and 2016 (dollars in thousands):



Derivatives in Cash Flow Hedging Relationships	Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)						Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)	Amount of (Loss) Reclassified from Accumulated OCI into Interest Expense (Effective Portion)						Location of (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Amount of (Loss) Recognized in Interest Expense (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Three months ended June 30,	2017			2016				2017			2016				2017			2016

Interest rate contracts	$	(3,863	)	$	(1,314	)	Interest Expense	$	(246	)	$	(1,131	)	Interest Expense	$	(11	)	$	(120	)

Six months ended June 30,

Interest rate contracts	$	(1,343	)	$	(5,019	)	Interest Expense	$	(918	)	$	(2,317	)	Interest Expense	$	(14	)	$	(163	)

Derivatives Not Designated as Hedging Instruments														Location of Loss Recognized in Income on Derivative	Amount of Loss Recognized in Income on Derivative
Three months ended June 30,															2017			2016

Preferred stock embedded derivative														Interest and other non-property income	$	(633	)	$	—

Six months ended June 30,

Preferred stock embedded derivative														Interest and other non-property income	$	1,720		$	—

Credit-Risk-Related Contingent Features

As of June 30, 2017, derivatives that were in a net liability position and subject to credit-risk-related contingent features had a termination value of $3.8 million, which included accrued interest but excluded any adjustment for nonperformance risk. These derivatives had a fair value, gross of asset positions, of $3.6 million at June 30, 2017.

Certain of our derivative contracts contain a provision where we could be declared in default on our derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to our default on the indebtedness. As of June 30, 2017, we had not breached the provisions of these agreements. If we had breached these provisions, we could have been required to settle our obligations under the agreements at the termination value of $3.8 million.

Although our derivative contracts are subject to master netting arrangements, which serve as credit mitigants to both us and our counterparties under certain situations, we do not net our derivative fair values or any existing rights or obligations to cash collateral on the Condensed Consolidated Balance Sheets.

We did not have any asset or liability derivative balances that were offsetting that would have resulted in reported net derivative balances differing from the recorded gross amount of derivative assets of $1.9 million and $2.4 million (excluding the preferred stock embedded derivative) as of June 30, 2017 and December 31, 2016, respectively, in addition to gross recorded derivative liabilities of $3.6 million and $7.6 million as of June 30, 2017 and December 31, 2016, respectively.

Other Comprehensive Income

MAA's other comprehensive income consists entirely of gains and losses attributable to the effective portion of our cash flow hedges. The chart below shows the change in the balance for the six months ended June 30, 2017 and 2016 (dollars in thousands):



Changes in Accumulated Other Comprehensive Income (Loss) by Component
	Affected Line Item in the Condensed Consolidated Statements Of Operations	Gains and Losses on Cash Flow Hedges
For the six months ended June 30,		2017			2016
Beginning balance		$	1,144		$	(1,589	)
Other comprehensive income (loss) before reclassifications		(1,343		)	(5,019		)
Amounts reclassified from accumulated other comprehensive income (interest rate contracts)	Interest expense	918			2,317
Net current-period other comprehensive (loss) income attributable to noncontrolling interests		16			141
Net current-period other comprehensive income (loss) attributable to MAA		(409		)	(2,561		)
Ending balance		$	735		$	(4,150	)

See also discussions in Note 9 (Fair Value Disclosure of Financial Instruments) to the Condensed Consolidated Financial Statements.

Interest Rate Derivative

Number of Instruments

Notional Amount

Interest Rate Caps

Interest Rate Swaps